Topic 3: Banking Structures Around the World The USA

Lecture Outline Important Features of the American Banking sector The decline of American Banks Regulation and other Factors Trends in American Banking Consolidation and Effects on International Banking American Banking Innovations Bank Holding Companies, ATMs, Non-Banks Unique US Financial Institutions Savings and Loans, Credit Unions

USA Banking System Important Features: US banking system has over 27,000 deposit taking institutions compared to just under 600 banks in the UK. Over the time the US banking sector has lost its dominance, particularly since 1974. The Bank of America remained in competition (rank 1 or 2 in the world) during 1968-83. In 1984, they were in 41st position. US banks weaknesses include developing country debt problems and decline in agriculture commodity and real estate prices. 1981 was the year when large bank failure started - 10 individual failures in 1981 and 1000 in 1989.

The Decline of the USA Banking System Overall, the competitiveness of the banking sector has declined in the USA due to the fact that companies with abundant liquid funds could obtain rates higher than commercial banks were offering. The failure of several reforms (e.g. the Banking Reform Bill in 1991) meant reliance on an outdated regulatory system for a significant period of time (however, this is now changing).

Structure and Regulations of the US Commercial Banking Industry There are around 2800 commercial banks in the USA, for more than in any other country in the world. In Canada or UK usually five or six major banks dominate the industry but in USA ten largest banks hold only 36% of the assets in their industry. Two-thirds of deposits are held by commercial banks, and the remaining by thrift institutions (discussed later). Restrictions and regulations on branches had resulted in more banks in competition.

Structure and Regulations of the US Commercial Banking Industry In the past, it had been a case that an American bank could open a branch in foreign country more easily than in other states within the USA. The McFadden-Pepper Act (1927), had effectively prohibited larger banks from opening branches across different states. But, from late 1990s, situation is changing. Regulation on branches particularly are being eased.

Commercial Bank Consolidation Bank failures in late 1980s and early 1990s had provided the base for consolidation. Bank consolidation was further stimulated by the passage of Riegle-Neal Interstate Banking and Branching Efficiency Act (1994). This legislation effectively overturned the McFadden Act which prohibited interstate banking. This Act had almost ensured interstate banking roughly in all 50 states.

Commercial Bank Consolidation It is anticipated that after consolidation has run its course, there will be roughly 4000 commercial banks rather than present 8500 Another important feature had been the separation of commercial banking from investment banking such as securities, insurance and real state business. Glass-Steagall Act (1933) had prohibited them from underwriting corporate securities or from engaging in brokerage activities.

Commercial Bank Consolidation In turn, this Act had also prohibited investment banks and insurance companies from engaging in commercial banking activities In 1997, however, the Federal Reserve allowed holding companied to underwrite securities and stocks. Initially it was a restriction that the revenue from these activities should be no more than 10% of total revenue (raised to 25% later on). Restrictions on commercial bank securities and insurance activities put American banks at a comparative disadvantage relative to foreign banks.

Commercial Bank Consolidation In 1999, US Congress had passed a bill, which effectively abolished the Glass-Steagall Act. This legislation, which is called Gramm-Leach-Bliley Financial Services Modernisation Act, allowed securities firms and insurance companies to purchase banks and allowed banks to underwrite insurance and securities and engage in real estate activities.

International Banking in USA In 1960s eight US banks operated branches in foreign countries and their total assets were less than $4 billion. Currently there are more than 100 American banks working abroad with assets totalling over $500 billion. The growth in foreign banks can be explained by: Expansion of international trade. Expansion of efficiently selling investment banking services abroad. US banks had most of their branched in Latin America, the Far East, the Caribbean and London.

International Banking in USA Due to trade expansion, foreign banks had been encouraged to do business in USA. These foreign banks had been very successful overall. These foreign banks are lending roughly the same amount of money to corporations as the US banks. These foreign banks are operating by using the agency offices, subsidiary banks and branches. Before 1978, foreign banks were under fewer regulations with no reserve requirements. However, the 1978 International Banking Act put foreign and domestic banks on equal footing.

Structure and Regulations of the US Commercial Banking Industry The regulatory restrictions on branches had resulted in three developments: Bank holding companies ‘Nonbank’ banks Automated Teller Machines (ATM)

Bank Holding Companies A holding company is a corporation that owns several different companies. The growth of holding companies over the time had been dramatic to avoid the branching restrictions, because the holding company can own a controlling interest in several banks even if branching is not permitted. These holding companies had been and can involve investment banking activities which were banned from commercial banking services.

‘Nonbank’ Banks Another way banks used to avoid branching restrictions was due to loopholes in the Bank Holding Act of 1956, which defined a bank as a financial institution that accepts deposits and makes loans. Once bank holding companies had recognized this loophole, they open branches with one function only (means offering loan facility or taking deposits only). However, the Competitive Act passed in 1981 had effectively filled this loophole.

ATMs The modern day facility of ‘ATM’ was originally invented to avoid branching restrictions in USA. Banks recognised that even if they don’t have ATM machines of their own, they could use rented machines to avoid branching restrictions. A number of these shared facilities such as Cirrus and NYCE have been established nationwide. States also had encouraged these ATM machines rather than “brick and mortar branches.” ATM machines gained in popularity with the advent of cheap computers.

Unique US Financial Institutions We will discuss two unique Financial Institutions: Savings and Loans Credit Unions

Savings and Loan Associations Not surprisingly, the regulations and structure of the thrift industry closely parallel the regulations and restrictions of the commercial banking industry. Just as there is dual banking for commercial banks, savings and loan association can be charted by the Federal government or by the states The Savings Association Insurance Fund (SAIF), a subsidiary of FDIC, provides Federal Deposit Insurance (up to $100,000 per account) for S &LS

Savings and Loan Associations The branching regulations for S&Ls were more liberal than for commercial banks: From 1980s federally charted S&Ls were allowed to branch state-wide in all states These S&Ls usually provides loans for mortgages on soft terms (low interest rates and longer repayment period). In late 1980s, these S&Ls started becoming involved in commercial banking activities.

Credit unions Credit unions are small cooperative lending institutions. They are the only financial institutions which are tax exempted and can be chartered either by the state or the federal government. The National Credit Union Share Insurance Fund (NCUSIF) provides insurance for deposits. These unions are permitted to do branching in all states w/o any problems.